We’re all saps in the stock market’s shell game

Insight: Investors’ exuberance will end badly, as it always does

By

MichaelSincere

Columnist

iStock

MIAMI (MarketWatch) — The stock market often resembles the shell game Three-Card Monte, an analogy that will become more obvious in the coming weeks.

In Three-Card Monte, it seems so easy to find the “money card.” But after placing a bet, victims invariably lose. Why? First, they are falsely led to believe they can win. Second, they don’t realize the other “players” are actually in on the fix.

In Wall Street’s version of this ruse, investors don’t realize how much misleading information is fed to them. This “analysis” is designed to make it appear that making money in the market is easy. As the Dow Jones Industrial Average
DJIA, -1.24%
and S&P 500
SPX, -1.54%make all-time highs, it seems like anyone can get rich.

And just like in Three-Card Monte, investors are looking in the wrong places for information. Instead of being mesmerized by the all-time highs, investors should be focused on the market’s deteriorating internal conditions.

For example, as the market climbs higher on lower volume, fewer and fewer stocks are participating (i.e. making new highs). This is a red flag.

Also, sentiment indicators are reaching extreme levels. The VIX
VIX, +32.45%
is at a six-year low; the RSI (relative strength indicator) has surpassed 70 (meaning the market is overbought), Investor’s Intelligence is over 60% bullish (the second-highest ever). So many large cap stocks have gone parabolic, there has to be a day of reckoning.

Moreover, margin balances are at record levels. When the market goes south, the excess margin will accelerate the downturn.

All of this translates into a stealth market bubble that keeps growing, but is happening so slowly few see it.

Everyone’s a winner

As the market makes all-time highs, more investors are lured into the game. One exuberant host on a financial program boldly stated: “This is a market that will never go down!” Another guest recently predicted that the stock market won’t go down for another two years.

If you believe these commentators, please sell your house to me for tulip bulbs and bitcoins.

Recently, I received emails from investors who believe my previous advice to move to cash is “dangerous” and “irresponsible.” Others are angry that I would dare suggest that the bull market is topping out and might end. A few bragged about how smart they are and how I am “crazy” for not buying stocks as the market climbs higher. To me, the hubris from these investors is another red flag.

The first clue that something isn’t right with the market (besides sky-high sentiment and margin) will be an abrupt break in the S&P 500. In other words, there will be a pivot (or inflection) point that signals more pain ahead.

Most of the indicators I look at are signaling trouble. Nevertheless, it’s hard to be patient and disciplined while waiting for the market to snap. When the tipping point comes, it will catch most investors, including many pros, by surprise.

That moment is coming sooner than later, but so far it’s taking longer than I anticipated. I have the patience to wait, however, and I’m comfortable making 0% (and even less with my short positions) as storm clouds appear. I know from the feedback I received that most people disagree with me, and that’s fine. Each person has to determine how much risk they are comfortable taking.

Unfortunately, it’s difficult to wait for the right time to pounce. It’s also not easy to avoid the market when it reaches bubble territory. After all, the market can still go higher, and those sitting on the sidelines feel left out and foolish.

Even more annoying, markets can remain overbought for long periods (which is why shorting stocks should be left to experienced investors who know how to manage risk). It’s also true that as the market rolls over, the Fed could step in and fuel the fire.

However, I’m reminded of the advice from financier Bernard Baruch. When asked how he became so wealthy at a young age, he replied: “I made my money by selling too soon.”

I also know from experience how this shell game ends, and it’s never pleasant. As the S&P 500 flirts with 2000 (and the Dow with 17,000), breaking more records, bullish investors will be blinded by their success. As fewer and fewer stocks join the party, as volume decreases, as sentiment enters the stratosphere, and when investors think the market “will never go down,” the mighty bull market will stumble and fall.

That’s when investors will realize they’ve played “Stock-Market Monte” — and lost.

Michael Sincere (www.michaelsincere.com) is the author of “Understanding Options,” “Understanding Stocks,” and “Predict the Next Bull or Bear Market and Win.”

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